Реферат: Business Аssociations
I.CHARACTERISTICSOF A CORPORATION
A.PRINCIPALCHARACTERISTICS OF A CORPORATION
a)EntityStatus--a corporation is a legal entity created under the authority oflegislature
b)LimitedLiability--as a legal entity, a corp is responsible for its own debts; its sh’sliability is limited to their investment;
c)FreeTransferability of Interest--shares, representing ownership interests, arefreely transferable;
d)CentralizedManagement and Control--a corp’s management is centralized in a board of dirsand officers. Shs have no direct control over the board’s activities;
e)Duration--Continuityof Existence--a corp is capable of perpetual existence;
f)Taxation--acorp, as an entity, pays taxes on its own income; shs are taxed only ondividends;
g)RememberAttributes of the Corporation--CLIFF:
4)Freelyalienable (shares can be sold).
B.CORPORATIONSDISTINGUISHED FROM OTHER FORMS OF BUSINESS ASSOCIATIONS.
1.GENERALPARTNERSHIPS--in most states, p’ships are governed by the Uniform PartnershipAct (UPA). However, the Revised UPA (RUPA) has been adopted by a few states
a)AggregateStatus--a p’ship is an aggregation of two or more persons who are engaged inbusiness as co-owners. Although not a legal entity, a p’ship is treated as onefor certain purposes, e.g., ownership and transfer of property. RUPA confersentity status on p’ships;
b)UnlimitedLiability--every partner is subject to unlimited personal liability on p’shipdebts;
c)Transferabilityof Interests--a partner cannot make a transferee a member of the p’ship. Shecan, however, assign his interest in the p’ship, thus permitting the assigneeto receive distributions of profits. Because the assignee does not become amember of the p’ship, he is not entitled to participate in p’ship business ormanagement.
d)Durationand Dissolution--a p’ship cannot have perpetual existence. It is terminable atwill unless a definite term is expressed or implied, and is also dissolved bydeath, incapacity, or withdrawal of any partner.
1)Wrongfuldissolution--p’ships can also be dissolved in contravention of the p’shipagreement, by the express will of any partner, by a court or by a partner’sconduct. Upon wrongful dissolution, nonbreaching partners may seek damages forbreach and, if they choose to do so, may continue the p’ship upon payment tothe breaching partner of the value of his interest.
1)Compare--dissociationunder RUPA--termination results in either the winding up of the p’ship orbuyout of the dissociating partner, depending on the event triggering thetermination. A buyout may be reduced by damages if dissociation was wrongful.
e)Managementand Control--absent a contrary agreement, every partner has a right toparticipate equally in the partnership management.
f)Autority--eachpartner, as an agent of the firm, may bind the p’ship by acts done for thecarrying on, in the usual way, the business of the p’ship.
1)RUPA--ap’ship is bound by a partner’s act for carrying on in the usual way either theactual p’ship business or a business of the kind carried on by the p’ship.
g)Ownershipof Property--title may be held in the name of the p’ship, but property is ownedby the individual partners as tenants in p’ship. There is no tenancy in p’shipunder RUPA, which provides that property acquired by p’ship is owned by p’ship,not individual partners.
h)Capacityto Sue and be Sued--under the UPA, a lawsuit may be brought by or againstindividual partners, rather than p’ship. Partners are jointly and severallyliable for wrongful acts and breaches of trust; they are only jointly liable fordebts and obligations of the p’ship.
1)Statutoryreforms--many state statutes specifically allow a p’ship to be sued in its ownname. Other states make all p’ship liabilities joint and several. Other reformsprovide that not all joint obligors need to be joined in a suit.
2)RUPA--ap’ship may sue and be sued in its own name, and partners are jointly andseverally liable for all p’ship obligations. A claim against the p’ship cannotbe satisfied from a partner’s personal assets unless p’ship assets have beenexhausted.
2.JOINTVENTURE--a p’ship formed for some limited investment or operation, as opposedto a continued business enterprise. Joint ventures are governed by the rulesapplicable to p’ships
3.LIMITEDPARTNERSHIP--this is a p’ship consisting of two classes of partners: generalpartners (with rights and obligations as in an ordinary p’ship) and limitedpartners (with no control and limited liability).
4.LIMITEDLIABILITY PARTNERSHIPS--in a LLP, a general partner is NOT personally liablefor all p’ship obligations arising from negligence, wrongful acts, andmisconduct absent his involvement in the misconduct. There is no exclusion forliability for contractual obligations.
5.LIMITEDLIABILITY COMPANIES--LLC is a non-corporate business entity whose owners(members) have limited liability and can participate actively in itsmanagement. An LLC may be either for a term or at will. It can be managedeither by its members or nonmember managers. Depending on the statute,distributions are made either equally to each member or in proportion to eachmember’s contribution.
a)Withdrawaland Dissolution--some statutes provide that any event that terminates amember’s membership (death, resignation) causes dissolution. Other statutesdistinguish between fault events(member misconduct...) and non-fault events(death, bankruptcy), and some provide that dissolution can be avoided by payingthe withdrawing member fair value for his interest.
b)Advantagesof LLCs--An LLC for a business association, not publicly held, has strongadvantages: partnership taxation, virtually no restrictions in structuringownership interests and management, limited liability for owners and managers, andno limitations on the number or nature of owners.
C.DISREGARDOF CORPORATE ENTITY--since a corp is a distinct legal entity, shs are normallyshielded from corporate obligations. In certain instances, however, thecorporate entity will be disregarded.
1.PIERCINGTHE CORPORATE VEIL--(Suits by corporate creditors against shs)--it’s morecommon in contract claims than in tort claims. The most important elementsconsidered by the courts:
a)Comminglingof Assets--commingling of corp assets and personal assets of shs (e.g., payingprivate debts with corp funds) may lead to piercing of the corporate veil;
b)Lackof Corporate Formalities--whether basic corp formalities (e.g., regularmeetings, corporate records maintained, issuance of stock) were followed is alsorelevant. Statutory close corps are permitted more flexibility regarding corpformalities;
c)Undercapitalization--ifthe corp was organized without sufficient capital or liability insurance tomeet obligations reasonably expected to arise, the corp veil may be pierced;
d)Dominationand Control By Shareholder--the corp veil is often pierced when an individualor other corp owns most or all of the stock, so that it completely dominatespolicy or business decisions.
e)”AlterEgo,” “Instrumentality,” “Unity of Interest”--when no separate entity existsand the corp is merely the alter ego or instrumentality of its shs (could be acorporate shareholder), or when there is a unity of interest between the corpand its shs, the corp veil is often pierced. These terms are usually appliedonly if other grounds are present;
f)Fraud,Wrong, Dishonesty, or Injustice--generally, the veil will be pierced only ifone of these elements is available, e.g., no piercing of veil if there is alack of corp formalities without resultant injustice. Piercing the veil usuallyinvolves corps with a small number of shs.
2.PIERCINGHAPPENS MOST OFTEN WHEN:
1)Thenumber of shs is small--the chance of one sh dominating the corp is greater;
2)Deception--Thereis some kind of deception;
3)Agency--individualis a “principal” and corp is his “agent”
4)Estoppel--outsiderwas led to believe that he was dealing with an individual, while in fact he wasdealing with the corporation.
5)Directtort--individual and corp acted together and should be jointly/severally liable
6)Instrumentalityrequirement is satisfied:
I)controlof a subsidiary by parent
iii)tocause loss or injury.
3.PIERCINGTHE WALL BETWEEN AFFILIATED CORPORATIONS--this occurs when a P with a claimagainst one corp attempts to satisfy the claim against the assets of anaffiliated corp under common ownership. This type of aggregation is permittedonly when each affiliated corp is NOT a free-standing enterprise but merely afragment of an entity composed of affiliated corps.
4.USEOF CORPORATE FORM TO EVADE STATUTORY OR CONTRACT OBLIGATIONS--the corp form maybe ignored when it is used to evade a statutory or contractual obligation. Theissue is whether the contract or statute was intended to apply to the shs aswell as the corporation. Only third parties, not the corp or its shs, aregenerally allowed to disregard the corp entity.
5.TWOEXTREMES TO AVOID IN PIERCING THE CORPORATE WALL:
a)Oldmodel--Superman (sh) used corp as his puppet;
b)NewModel--Superman (sh) and corp are inseparable (alter ego)
D.SUBORDINATIONOF SHAREHOLDER DEBTS--”DEEP ROCK” DOCTRINE--if a corp goes into bankruptcy,debts to its controlling shs may be subordinated to claims of other creditors.When subordination occurs, shareholder loans are treated as if they wereinvested capital (stock). Major factors in determining whether to subordinateinclude fraud, mismanagement, undercapitalization, commingling, excessivecontrol, etc.
II.ORGANIZINGTHE CORPORATION--generally, corps are created under and according to statutoryprovisions of the state in which formation is sought.
A.FORMALITIESIN ORGANIZING CORPORATION:
1.CERTIFICATEOR ARTICLES OF INCORPORATION--state law governs the content of the articles,which are filed with the secretary of the state. Usually, the articles mustspecify the corp name, number of shares and classes of stock authorized,address of the corp’s initial registered office, name of initial registeredagent, and the name and address of each incorporator.
a)PurposeClause--under most statutes, no elaborate purpose clause is needed. It issufficient to state that the purpose of the corp is to engage in any lawfulbusiness activity.
b)Stateof Incorporation--incorporators need to consider how flexible the state’scorporate law is versus the costs associating with incorporating in that state
2.ORGANIZATIONALMEETING--filling the articles in proper form creates the corporation, afterwhich an organizational meeting is held by either the incorporators or dirsnamed in the articles. Matters determined at meeting:
1)Incorporatorselect directors, if no dirs are named in the articles;
3)Directorsratify pre-incorporation transactions;
4)Directorsauthorize issuance of shares
5)Directorsadopt by-laws (if necessary), corporate seal and stock certificate
B.DEFECTSIN FORMATION PROCESS--”DE JURE” AND “DE FACTO” CORPS--when there is a defect orirregularity in formation, the question is whether the corp exists “de jure,”“de facto,” “by estoppel,” or not at all. This issue usually arises when athird party seeks to impose personal liability on would-be shs. Another methodof challenging corporate status, used only by the state, is a quo warrantoproceeding. Note: where there has not been compliance with the statute, weapply principles of de facto, de jure and corp by estoppel. Where there hasbeen compliance with the statute, we apply principles of disregard of corporatefiction, a/k/a “piercing the corporate veil,” which is an exception, ratherthan a rule.
1.DEJURE CORPORATION--this exists when the corp is organized in compliance with thestatute. Its status cannot be attacked by anyone--not even the state. Mostcourts require only “substantial compliance”; others require exact compliancewith the mandatory requirements.
2.DEFACTO CORPORATION (substantially abolished)--this exists when there isinsufficient compliance as to the state (i.e., state can attack in quo warrantoproceeding), but the steps taken are sufficient to treat the enterprise as acorp with respect to its dealings with third parties. Requirements:
1)Colorableor apparent attempt;
3)Someuse of corporate franchise; Then ct will recognize status as to all but state
a)Definition--estoppelis an equitable evidentiary rule which prevents a party from denying theexistence of a fact notwithstanding that he fact is not true. Thus, certainparties are estopped from asserting defective incorporation when they havedealt with the corp as though properly formed.
b)Example--shswho claimed corp status in an earlier transaction are estopped to deny thatstatus in a suit brought against the corp. The estoppel theory normally doesNOT apply to bar suits against would-be shs by tort claimants or otherinvoluntary creditors.
c)OverlapWith De Facto--many of the facts which we would point to support a claim of defacto status are the same ones we point for estoppel. However, substantialabolition of de facto concept doesn’t necessarily abolish estoppel.
d)DeFacto is For All; Estoppel is For One--estoppel depends on relationship betweenparty and corp.
4.WHOMAY BE HELD LIABLE--when a would-be corp is not a de jure or de facto or a corpby estoppel, the modern trend imposes personal liability against only thoseowners who actively participated in management of the enterprise.
a)On DeFacto Doctrine--states following the prior version of the Model Act haveabolished the de facto doctrine, thus making all purported “shs” jointly andseverally liable for all liabilities incurred as a result of the purported“incorporation.” However, statutes based on Revised Model Business CorporationAct require a person acting on behalf of the enterprise to know that there wasno incorporation before liability attaches.
b)OnEstoppel Doctrine--the effect of both acts is an unsettled issue.
c)OnLiability--under the prior Model Act, liability extends to investors who alsoexercise control or actively participate in policy and operational decisions.It is expected that the Revised Model Act will be interpreted in the samemanner.
III.LIABILITIESFOR TRANSACTIONS BEFORE INCORPORATION.
A.PROMOTERS--apromoter participates in the formation of the corp, usually arrangingcompliance with the legal requirements of formation, securing initial capital,and entering into necessary contracts on behalf of the corp during the timeit’s being formed.
a)FiduciaryDuties to Each Other--Full disclosure and fair dealing are required between thepromoters and the corp and among promoters themselves.
B.CONTRACTSMADE BY PROMOTERS ON CORP’S BEHALF
1.RIGHTSAND LIABILITIES OF CORPORATION:
a)EnglishRule--the corp is not directly liable on pre-incorporation contracts even iflater ratified. Rationale: the corp was not yet in existence at the time thepromoter was acting.
b)AmericanRule--the corp is liable if it later ratifies or adopts pre-incorporation K.
c)Corporation’sRight to Enforce Contract--under either rule, the corp may enforce the contractagainst the party with whom the promoter contracted, if it chooses to do so.
2.RIGHTSAND LIABILITIES OF PROMOTERS.
a)Liabilityon Pre-incorporation Contract--generally, promoters are liable if the corprejects the pre-incorporation contract, fails to incorporate, or adopts acontract but fails to perform, unless the contracting party clearly intended tocontract with the corporation only and not with the promoters individually.
b)Rightto Enforce Against the Other Party--if a corp is not formed, the promoter maystill enforce the contract.
C.OBLIGATIONSOF PREDECESSOR BUSINESS--a corporation that acquires all of the assets of apredecessor business does not ordinarily succeed to its liabilities, withexceptions:
a)Exceptions--thesuccessor corp may be liable for its predecessor liabilities if:
1)thenew corp expressly or impliedly assumes the predecessor obligations (thecreditors of the old corp may hold the new corp liable as third-partybeneficiaries);
2)thesale was an attempted fraud on the creditors; or
3)thepredecessor is merged into or absorbed by the successor.
IV.POWERSOF THE CORPORATION.
A.CORPORATEPOWERS--generally, corporate purposes and powers are those expressly set forthin the corporation’s articles, those conferred by the statute, and the impliedpowers necessary to carry out the express powers. Transactions beyond thepurposes and powers of the corporation are ultra vires.
1.TRADITIONALPROBLEM AREAS--the following three powers are particularly significant expresspowers, since older statutes did not specifically confer them:
a)Guarantees--modernstatutes confer the power to guarantee the debts of others if it is infurtherance of the corporate business;
b)Participationin a Partnership--present-day statutes explicitly allow the corp to participatewith others in any corp, partnership, or other association;
c)Donations--becausethe general rule is that the objective of a business corporation is to conductbusiness activity with a view to profit, early cases held that charitablecontributions were ultra vires; the modern view permits reasonable donationswithout showing the probability of a direct benefit to the corp.
1.DEFINITION--agencyis the fiduciary relation which results from the manifestation of consent byone person to another that the other shall act on his behalf and subject to hiscontrol, and consent by the other to so act." Rest2dAg
a)Partiesto an agency relationship--Principal & Agent. Thus, three essentialelements of an agency relationship:
1)Manifestationby principal that agent shall act for him in some undertaking;
2)Acceptanceby the agent; and
3)Understandingthat the principal is in control of the undertaking.
I)Notethat these are factual issues; if they are satisfied, then the relationship isone of agency, regardless of what the parties themselves call it (but theparties' labels may provide evidence of their intent)
a)ActualExpress Authority--authority is the power of the agent to affect the legalrelations of the principal by acts done in accordance with the principal'smanifestations of consent to him." Rest §7. Operative word is«manifestation». If he says, do something, it's express ‑‑but the manifestation may include implied assent to other things as well, whichis--b)Actual Implied Authority--unless otherwise agreed, authority to conduct atransaction includes authority to do acts which are incidental to it, usuallyaccompany it, or are reasonably necessary to accomplish it." Rest § 35
c)ApparentAuthority ‑‑ a.k.a. «ostensible authority»--apparentauthority is the power to affect the legal relationships of another person bytransactions with third persons, professedly as agent for the other, arisingfrom and in accordance with the other's manifestations to such thirdpersons." Rest §8. But note that the manifestation includes allowing theagent to represent accurately his own authority.
d)InherentAuthority--this is the authority that inheres in an office. General agent(agent authorized to conduct a series of transactions involving continuity ofservice): P is bound if A is acting in the interests of P and A does an actusual or necessary with respect to the authorized transactions ;
1)Unusualactivities--depositing corporate checks on a personal account is an unusualactivity, and the bank should make inquiry if the person is authorized to dothat; otherwise, the bank is liable to the principal for lost money (Mohr)
e)Ratification--ratificationis the affirmance by a person of a prior act which did not bind him but whichwas done or professedly done on his account, whereby the act, as to some or allpersons, is given effect as if originally authorized by him." Rest § 82.The principal can affirm by words, or by deeds. This includes the failure torepudiate the subject matter when presented, suing to enforce the obligation,retaining the benefits of the transaction. Note several things:
1)Ratificationassumes that the principal was not previously bound. If the principal had beenpreviously bound, then the liability would be based on another agency theory.
2)Itdoesn't matter to whom the affirmance is made. It could be to the agent, to thethird party, or anyone else or nobody at all. Why? Because what was lacking inthe original contract was merely his expression of assent to the relationshipof agency. The terms are fixed, the third party believes he has an agreement,all that's missing is the opposite party. So the President of the firm's noteto himself that the affirms may be sufficient. If there are some formalitiesrequired to authorize an act ‑‑e.g., sealed instruments, deeds ‑‑then there might be additional formality required for affirmance.
f)Estoppel--purportedprincipal either (a) intentionally or carelessly causes the belief that apurported agent is acting on his behalf, or (b) sits silently knowing that suchbelief exists without taking reasonable steps, and the third party reliesdetrimentally.
C.ULTRAVIRES TRANSACTIONS--those beyond the purposes and powers, express and implied,of the corporation. Under common law, shareholder ratification of an ultravires transaction nullified the use of an ultra vires defense by thecorporation.
1.TORTACTIONS--ultra vires is NO defense to tort liability.
2.CRIMINALACTIONS--claims that a corporate act was beyond the corp’s authorized powersare NO defense to criminal liability.
3.CONTRACTACTIONS--at common law, a purely executory ultra vires contracts were NOTenforceable against either party; fully performed contracts could NOT berescinded by either party; and, under the majority rule, partially performedcontracts were generally enforceable by the performing party, since thenonperforming party was estopped to assert an ultra vires defense.
4.STATUTES--moststates now have statutes that preclude the use of ultra vires as a defense in asuit between the contracting parties, but permit ultra vires to be raised incertain other contexts:
a)SuitsAgainst Officers or Directors--if performance of an ultra vires contractresults in a loss to the corp, it can sue the officers or dirs for damages forexceeding their authority.
b)SuitBy State--these limiting statutes do NOT bar the state from suing to enjoin acorp from transacting unauthorized business.
c)BroadCertificate Provisions--when the certificate of incorporation states that thepurpose is to engage in any lawful activity for which corp may be organized,ultra vires is unlikely to arise.
A.ALLOCATIONOF POWERS BETWEEN DIRECTORS AND SHAREHOLDERS
1.MANAGEMENTOF CORPORATION’S BUSINESS--corporate statutes vest the power to manage in theboard of directors, except as provided by valid agreement in a close corp. Heboard’s power is limited to proper purposes.
2.SHAREHOLDERAPPROVAL OF FUNDAMENTAL CHANGES--shs must approve certain fundamental changesin the corp, e.g., amendment of articles, merger, sale of substantially allassets, and dissolution.
3.POWERTO ELECT DIRECTORS--shs have the power to elect dirs and to remove them forcause, absent provisions for removal without cause in the certificate, bylaws,or in statutes. Some statutes also permit the board or the courts to remove adir for certain specific reasons (e.g., felony conviction).
4.POWERTO RATIFY MANAGEMENT TRANSACTIONS--shs have the power to ratify certainmanagement transactions and insulate the transactions against a claim thatmanagers lacked authority, or shift the burden on the issue of self-interest.
5.POWERTO ADOPT PRECATORY RESOLUTIONS--shs may also adopt advisory but nonbinding(precatory) resolutions on proper subjects of their concern.
6.BYLAWS--shsusually have the power to adopt and amend bylaws, although some statutes givethe board of dirs the concurrent power to do this.
7.CLOSECORPORATION--this is a corp owned by a small number of shs who may activelymanage; it has no general market for its stock, and it has some limitationsregarding transferability of stock.
8.STATUTORYCLOSE CORPORATION STATUS--the basic requirements to qualify for specialtreatment under the statutes are that, in its cert of incorp’n, a statutoryclose corp must identify itself as such, and must include certain limitationsas to the number of shs, transferability of shares, or both.
a)FunctioningAs a Close Corporation--there may be sh agreements relating to any phase of thecorp affairs.
1.APPOINTMENTOF DIRECTORS--initial dirs are either designated in the articles ofincorporation or elected at a meeting of incorporators. Subsequent electionsare by shs at their annual meetings. The number of dirs is usually set by thearticles or bylaws.
a)Qualifications--absenta contrary provision in the articles or bylaws, dirs need not be shs of thecorp or residents of the state of incorporation.
b)Vacancies--statutesvary, but under Model Act, a vacancy may be filled by either the shs or dirs.
1)Compare--removal:some statutes require that vacancies created by removal of a dir be filled bythe shs unless the articles or bylaws provide otherwise.
a)Termof Appointment--under most statutes, office is held until the next meeting,although on a classified board, dirs may serve staggered multi year terms.
b)Powerto Bind Corporation Beyond Term--unless limited by the articles, the board hasthe power to make contracts biding the corp beyond the dirs’ term of office.
c)Removalof Director During Term--at common law, shs can remove a dir for cause (e.g.,fraud, incompetence, dishonesty) unless an article or bylaw provision permitsremoval without cause. a dir being removed for cause is entitled to a hearingby shs before a vote to remove. a number of statutes permit removal withoutcause.
1)Removalby Board--board can NEVER remove a dir unless authorized by statute;
2)Removalby Court--there is a split authority as to whether a court can remove a dir forcause.
I)Statutes--somestatutes permit courts to remove a dir for specified reasons. Usually, apetition for removal can be brought only by a certain percentage of shs or theattorney general.
a)Meetings--absenta statute, dirs can act only at a duly convened meeting consisting of a quorum.In most jurisdictions, a meeting can be conducted by telephone or other meanswhereby participants can hear each other simultaneously. Most statutes alsoallow board action by unanimous written consent without a meeting.
1)Notice--althoughformal notice is unnecessary for a regular meeting, special meetings requirenotice to every dir of date, time, and place. Usually, notice can be waived inwriting before or after a meeting. Attendance waives notice unless the dirattends only to protest the meeting.
2)Quorum--amajority of the authorized number of dirs constitutes a quorum. Many statutespermit the articles or bylaws to require more than simple majority or less thanthat.
3)Voting--absenta contrary provision, an affirmative vote of a majority of those present, not amajority of those voting, is required for board action.
b)Effectof Noncompliance With Formalities--today, most courts hold that informal butunanimous approval of a transaction is effective, as is a matter receiving theexplicit approval by a majority of dirs without a meeting, plus acquiescence bythe remaining dirs.
c)Delegationof Authority--the board has the power to appoint committees of its own membersto act for it either in particular matters or to handle day-to-day managementbetween board meetings. Typically, these committees cannot amend the articlesor bylaws, adopt or recommend major corporate changes (e.g., merger), recommenddissolution, declare a dividend, or authorize issuance of stock unlesspermitted by the articles or bylaws. Note that while the board may delegateoperation of the business to an officer or management company, the ultimatecontrol must be retained by the board.
d)ProvisionalDirectors--some statutes allow them to be appointed by court if the board isdeadlocked and corporate business is endangered. a provisional dir serves untilthe deadlock is broken or until removed by a court order or by majority of shs.
e)VotingAgreements--an agreement in advance among dirs as to how they will vote is voidas contrary to public policy. There are certain exceptions for statutory closecorps.
4.COMPENSATION--dirsare NOT entitled to compensation unless they render extraordinary services orsuch compensation is otherwise provided for. Officers are entitled toreasonable compensation for services.
5.DIRECTORS’RIGHTS, DUTIES, AND LIABILITIES
a)Rightto Inspect Corporate Records--if done in good faith for purposes germane to hisposition as dir, this right is absolute.
b)Dutyof Care--dirs must exercise the care of an ordinarily prudent and diligentperson in a like position, under similar circumstances. There is no liability(absent a conflict of interest, bad faith, illegality, or gross negligence) forerrors of judgment (business judgment rule--the rebuttable presumption thataction was taken on an informed basis, in good faith and exercising reasonablecare), but the dir must have been reasonably diligent before the rule can beinvoked (Shlensky)
1)Theduty of care requires:
I)Education--adir should acquire at least a rudimentary understanding of the business of thecorporation;
ii)Information--adir is under a continuing obligation to keep informed about the activities ofthe corp;
iii)Participation--dirsmust “generally monitor” corporate affairs, but need NOT involve themselves inthe day-to-day operations; (i.e. they should attend board of dirs meetings withreasonable regularity).
iiii)Inquiry--adir has a duty to inquire when circumstances would alert a reasonable personfor the need of inquiry.
iiiii)Action--wherewrongdoing is revealed, a dir should object, correct, or resign. Object to thecourse of conduct, steer toward correction, and resign if it isn’t corrected.
2)Extentof liability--dirs are personally liable for corporate losses directlyresulting from their breach of duty or negligence in falling to discoverwrongdoing. a director may seek to avoid being held personally liable for actsof the board by recording his dissent.
I)Manystatutes permit the articles to abolish or limit dir’s liability for breach ofthe duty of care absent bad faith, intentional misconduct, or knowing violationof law.
3)Defensesto liability--these include good faith reliance on management or expert’sreports. Disabilities may be considered in determining whether the dir has metthe standard of care.
c)Dutyof Loyalty--a catch-all duty designed to prevent unfairness--the duty to act ingood faith (BJR applies). Application:
(1)earlyabsolute prohibition against self-dealing renders transactions void orvoidable;
(2)permissiveself-dealing: dirs and officers may contract with the corp if (a)done in“strictest good faith.”; (b)with full disclosure; and (c)consent of “allconcerned.”
--burdenof proof is on the dir to establish good faith, honesty & fairness;
--courtsweigh self-dealing transactions with “closest scrutiny”
(3)self-dealingprohibition also applies to intercorporate transactions where dirs are common.
(1)quasi-safeharbor approach (Iowa statute)--transaction is not void or voidable because ofdirs’ interest, if either:
--interestis disclosed and approval is made without counting the vote of the interesteddir.
--interestis disclosed to shs and shs authorize
--transactionis fair and reasonable
(2)Note--dirmust still establish that he acted in good faith, honesty, and fairness
2)Dominationof subsidiary by parent--courts look at the transaction to see if self-dealinghas occurred. Example (Sinclair Oil):
I)declarationof dividends shared pro rata was NOT self-dealing; BJR applies
ii)contractbetween parent and sub was self-dealing; apply intrinsic fairness test
I)Ordinarycorporations--conflicts are inevitable but all firms need to set compensation.The burden of proof is placed on challengers as a matter of convenience.
ii)Closecorporations--the income generated by the firm may be diverted to salaries, sothere is an option for self-dealing by the parties in control to taketax-advantaged compensation in the form of salaries (taxed once) as opposed todividends (taxed twice).
d)StatutoryDuties and Liabilities--in addition to general duty of care, federal and statelaws also impose certain duties and liabilities, e.g., registrationrequirements under the Securities Act of 1933, liability for rule 10b-5violations, liability for illegal dividends. Some statutes also impose criminalliability on corporate managers for unlawful corporate actions.
1.ELECTION--officersare usually elected by the board of dirs. Some statutes permit election ofofficers by shs.
2.AUTHORITYOF CORPORATE OFFICERS (liability of corp to outsiders)--only authorizedofficers can bind the corp. Authority may be: actual (expressed in bylaws or byvalid board resolution), apparent (corp gives third parties reason to believeauthority exists), or power of position (inherent to position). If ratified bythe board, even unauthorized acts can bind the corp.
a)Authorityof President--the majority rule is that the president has the power to bind thecorp in transactions arising in regular course of business.
3.DUTIESOF CORPORATE OFFICERS--the duty of care owed by a officer is similar to thatowed by dirs ( and sometimes higher).
D.CONFLICTSOF INTEREST IN CORPORATE TRANSACTIONS.
1.DUTYOF LOYALTY--because of their fiduciary relationship with the corp, officers anddirs have the duty to promote the interests of the corp without regard forpersonal gain.
2.BUSINESSDEALINGS WITH THE CORPORATION--conflict of interest issues arise when a corptransacts business with one of its officers or dirs, or with a company in whichan officer or dir is financially interested.
a)Effectof Self-Interest on Right to Participate in Meeting--most statutes permit an“interested” dir to be counted toward quorum, and interested dir’s transactionsare NOT automatically voidable by the corp because the interested dir’s votewas necessary for approval.
b)VoidabilityBecause of Director’s Self-Interest--today, such transactions are voidable onlyif unfair to the corporation. The burden of establishing fairness is on theinterested director. Note that a dir’s failure to fully disclose material factsmay be per se unfair.
1)Unanimousshareholder ratification--if, after full disclosure, shareholder ratificationis unanimous, the corp will be estopped from challenging the transaction withthe interested dir (except at to creditors).
I)Less-than-unanimousratification--courts then will look at whether the majority shares were ownedor controlled by the interested director. Courts are more likely to upholdratification by a disinterested majority so as to preclude the transaction frombeing attacked by the corp or by a sh in a derivative suit.
2)Statutes--moststatutes provide that such transactions are NOT voidable if: (1)approved, afterfull disclosure, by a disinterested board majority or by majority of shs, or(2)the transaction is fair to the corp notwithstanding disclosure.
I)”Interested”--an“interested” dir or officer is one who has a business, financial, or familialrelationship with a party to the transaction that would reasonably affect theperson’s judgment so as to adversely affect the corp.
c)Remedies--thecorp may rescind, or affirm and sue for damages.
3.INTERLOCKINGDIRECTORATES--generally, transactions between corps with common dirs aresubject to the same rules of interested director transactions. There is noconflict of interest if one corp is the wholly owned subsidiary of the other.However, a question of fairness arises where the parent owns only a majority ofthe subsidiary’s shares.
4.CORPORATEOPPORTUNITY DOCTRINE (Also see duty of loyalty)
a)Definition--CODbars dirs from taking any business opportunity belonging to the corp withoutfirst offering it to the corp… If the corp is unwilling to pursue anopportunity (after an independent board is fully informed of the opportunity),then the dir may pursue it.
b)Defenses(available in most, but not all jurisdictions):
1)Inability--Ifthe corp is legally or financially unable to take the opportunity, then the dirgenerally may take advantage of it. (But the question of who caused thefinancial inability is quite relevant. Example: Irving Trust Co--the defense ofinability was rejected).
2)Rejection,abandonment, or approval--then the fiduciary has a valid defense.
c)Remedies--constructivetrust or damages--the fiduciary must account to the firm for all the profits hehas made as a result of usurpation.
d)Definitionof a Corporate Opportunity:
1)Lineof business test--does the firm have fundamental knowledge, practicalexperience, and ability to pursue the opportunity? If yes, then it is withinthe firm’s line of business. It should be a natural fit, and not a mere desireby a firm to pursue the opportunity.
e)Application--GuthRule and Corollary:
1)Guthrule (offered in corporate capacity)--if there is presented to O/D a businessopportunity which the corp is (1)financially able to undertake, which is fromits nature (2a) in the line of business and is of practical advantage to it OR(2b)is one in which the corp has an interest or reasonable expectancy (under anestablished corporate policy or plan), and, (3)by embracing the opportunity theself-interest of the dir will be brought into conflict with that of his corp,then officer or dir may NOT take the opportunity.
2)Guthcorollary (a safe harbor; satisfy all provisions and dir can take)--if abusiness opportunity (1)comes to O/D in his individual capacity and (2) is notessential to the corp and is (3)one in which corp has no interest orexpectancy, then the O/D can treat it as his own, IF he has not taken corporateresources to pursue the opportunity.
I)”Essential”--indispensablynecessary to the continued viability of the firm;
ii)Individualor corporate? Look at O/D capacity to determine how offer was made
5.COMPETINGWITH CORPORATION--such competition by a dir or officer may be a breach offiduciary duty even when the competing business is not a corporate opportunity
6.COMPENSATIONFOR SERVICES TO THE CORPORATION--the compensation plan must be duly authorizedby the board, and its terms must be reasonable. Good faith and the BJRordinarily protect disinterested dirs from liability to the corp for approvingcompensation.
a)PubliclyHeld Corporations--The SEC has authorized shs to make proposals about executivepay in management’s proxy statements. Further, the tax code now limits expensedeductions for executive pay over $1mln, unless it is tied to the corp’sperformance.
b)Pastand Future Services--compensation for past services is generally invalid. Compensationfor future services is proper if there is reasonable assurance that the corpwill receive the benefit of the services.
VI.INSIDERTRADING--purchase or sale of securities by someone with access to material
nonpublicinformation. It may be illegal. It affects corps with more than $1 mln in totalassets and with at least 500/750 shs.
a)Whomay be hurt by insider trading:
1)Targetshareholders--they sell too early;
2)Otherarbitrageurs--they lose a portion of the gain that they make from honest effort
3)Otherissuers--they lose confidence in the stock market
4)Theacquiring company--insider trading drives up their cost of acquisition, sincethe target may adopt defensive measures otherwise not in place.
b)PossibleSources of Liability:
3)10b-5misappropriation theory (O’Hagan);
4)Mailor wire fraud;
6)Statutoryliability under 16(b)--insiders are forced to give their profits to the corp,if the y buy and sell securities within a 6-month period regardless of whetherthey are using insider info. (Need to know 2, 3, 6)
c)O’Hagan--insidertrading violation where a partner in law firm took info rom his firm regardingthe firm’s client’s plans for acquisition of Pillsbury and used that info tobuy shares in Pillsbury
d)PenaltiesFor Insider Trading--ITSA (Insider Trading Sanctions Act)--3 measures:
1)Out-of-pocketmeasure--if a sh buys a share for $10, while in fact it costs $9, hisout-of-pocket expense is $1.
2)Causation-in-fact--becausean insider engaged in insider trading, it caused a loss
3)Disgorgement--welook at D’s profit. ITSA measures the damage to sh by the amount of profit thatD received from the transaction.
2)SECcivil penalties--treble damages; SEC may seek penalty capped by three timesprofit gained or loss avoided.
A.COMMONLAW--under the majority rule, there was no duty to disclose to the shs insideinfo affecting the value of shares. Therefore, the protection of investors wasvery weak.
a)Forlability to exist there should be:
1)Atleast fraud or deceit upon purchasers;
2)Mayalso be a device or scheme;
3)Mayalso be an implied misrepresentation.
b)TwoElements (relationship and unfairness):
1)Relationship--existenceof a relationship giving access, directly or indirectly, to informationintended to be available for a corporate purpose and no other.
I)Insidersinclude at least officers, dirs, controlling shs (In re Cady Roberts)
ii)Personscharged with confidentiality by contractual or fiduciary relationship
2)Unfairness--inherentunfairness that results when a party takes advantage of such informationknowing it is unavailable to person with whom he is dealing.
B.SECURITIESEXCHANGE ACT OF 1934--IN GENERAL--the act superseded common law. Section 12 ofthe Act requires registration of any security traded on a national exchange, orany equity security (held by 500 or more persons) of a corp with assetsexceeding $5 million.
C.SECTION10(B) AND RULE 10B-5--section 10(b) prohibits any manipulation or deception inthe purchase or sale of any security, whether or not it’s registered. Rule10b-5 prohibits the use of the mails or other instrumentality of interstatecommerce to defraud, misrepresent, or omit a material fact in connection with apurchase or sale of any security.
1.COVEREDCONDUCT--rule 10b-5 applies to nondisclosure by dirs or officers, as well as tomisrepresentations. It applies not only to insider trading but also to anyperson who makes a misrepresentation in connection with a purchase or sale ofstock.
2.COVEREDSECURITIES--rule 10b-5 applies to the purchase or sale of any security,registered or unregistered. a jurisdictional limitation requires that theviolation must involve the use of some instrumentality of interstate commerce.
3.WHOCAN BRING SUIT UNDER 10B-5--private plaintiffs and the SEC. Private plaintiffsmust be either purchasers or sellers of security.
4.MATERIALITY--forrule 10b-5 to apply, the information misrepresented or omitted must be material(i.e., a reasonable sh would consider it important in deciding whether to buyor to sell).
5.FAULTREQUIRED (SCIENTER)--a defendant is not liable under rule 10b-5 if he waswithout fault or merely negligent. The scienter requirement is satisfied byrecklessness or an intent to deceive, mislead, or convey a false impression.Scienter is also required for injunctive relief.
1)Dknew the hazard and proceeded nonetheless (subjective test);
2)Dproceeded despite what a reasonable person would perceive (objective test);
1)Knowingconduct-- yields jointly and severally liable;
2)Non-knowingconduct (e.g., recklessness)--yields fair share (proportionate liability),found in accordance with special interrogatories.
6.CAUSATIONAND RELIANCE--a plaintiff must prove that violation caused a loss (i.e., hemust establish reliance on the wrongful statement or omission). However, inomission cases, there is a rebuttable presumption of reliance once materialityis established.
a)FraudOn The Market--where securities are traded on a well-developed market (ratherthan in a face-to-face transaction), reliance on a misrepresentation may beshown by alleging reliance on the integrity of the market.
b)Face-to-FaceMisrepresentations--a plaintiff can show actual reliance in these cases byshowing that the misrepresentation was material, testifying that he relied uponit, and showing that he traded soon after misrepresentation.
7.WHENNONDISCLOSURE CONSTITUTES a VIOLATION
a)MerePossession of Material Information--generally, nondisclosure of material,nonpublic information violates rule 10b-5 only when there is a duty to discloseindependent of rule 10b-5
b)InsiderTrading--insiders (dirs, officers, controlling shs and corporate employees)violate rule 10b-5 by trading on the basis of material, nonpublic info obtainedthrough their positions. They have a duty to disclose before trading.
c)Misappropriation--theliability of noninsiders who wrongfully acquire (misappropriate) materialnonpublic info has not been ruled upon by the US Supreme Court, although somelower level federal courts have imposed criminal liability.
1)Dutyto Employer--using the misappropriation theory, criminal liability under rule10b-5 has been imposed where an employee trades on info used in violation ofthe employee’s fiduciary duty to his employer. An employee’s duty to “abstainor disclose” with respect to his ER does NOT extend to the general public.However, the Insider Trading and Securities Fraud Enforcement Act of 1988 makesany person who violates rule 10b-5 by trading while in possession of material,nonpublic info liable to any person who, contemporaneously to the transaction,purchased or sold securities of the same class. Liability is limited to thedefendant’s profit or avoided loss.
2)Mailand wire fraud--the application of the federal mail and wire fraud statute tothis situation lessens the importance of the misappropriation theory inimposing criminal liability under rule 10b-5.
3)Specialrule for tender offers--once substantial steps toward making a tender offerhave begun, it is a fraudulent, deceptive, or manipulative act for a personpossessing material information about the tender offer to purchase or sell anyof the target’s stock, if that person knows that the info is nonpublic and hasbeen acquired from the bidder, the target, or someone acting on the bidder’s orthe target’s behalf.
d)”Discloseor Abstain”--nondisclosure by a person with a duty to disclose violates rule10b-5 only if he trades (Cady rule)
8.LIABILITYOF NONTRADING PERSONS FOR MISREPRESENTATION--a nontrading corp or person whomakes a misrepresentation that could cause reasonable investors to rely thereonin the purchase or sale of securities is liable under rule 10b-5, provided thescienter requirement is satisfied.
9.LIABILITYOF NONTRADING CORPORATION FOR NONDISCLOSURE--the basic principle is “discloseor abstain.” Thus, a nontrading corp is generally not liable under rule 10b-5for nondisclosure of material facts.
a)Exceptions--acorp has a duty to:
1)Correctmisleading statements (even if unintentional);
2)Updatestatements that have become materially misleading by subsequent events;3)Correct material errors in statements by others (e.g, analyst’s report) aboutthe corp, but only if the corp was involved in the preparation of thestatements; and
4)Correctinaccurate rumors resulting from leaks by the corp or its agents.
10.TIPPEEAND TIPPER LIABILITY--a person, not an insider, who trades on info receivedfrom an insider is a tippee and may be liable under rule 10b-5 if he receivedinfo through an insider who breached fiduciary duty in giving the info, AND thetippee knew or should have known of the breach (Dirks)
a)Breachof Insider’s Fiduciary Duty--whether an insider’s fiduciary duty was breacheddepends largely on whether the insider communicated the info to realize thegain or advantage. Accordingly, tips to friends or relatives and tips that area quid pro quo for a past or future benefit from the tippee result in fiduciarybreach. Note that if a tippee is liable, so is the tipper.
11.”TEMPORARYINSIDERS”--corporate info legitimately revealed to a professional or consultant(e.g., accountant) working for the corp may make this person a fiduciary ofcorp
12.AIDERSAND ABETTORS--liability cannot be imposed solely because a person aided andabetted the violation of the rule.
13.APPLICATIONOF RULE 10B-5 TO BREACH OF FIDUCIARY DUTY BY DIRECTORS, OFFICERS, ANDCONTROLLING SHAREHOLDERS.
a)OrdinaryMismanagement--a breach of fiduciary duty not involving misrepresentation,nondisclosure, or manipulation does NOT violate rule 10b-5;
b)Misrepresentationor Nondisclosure--if this is the basis of a purchase from or sale to the corpby a dir or officer, the corp can sue the fiduciary under rule 10b-5 and alsofor breach of fiduciary duty. If the corp doesn’t sue, a minority sh canmaintain a derivative suit on the corporations behalf.
c)Purchaseor Sale By Controlling Shareholder--when a corp purchases stock from or sellsstock to a controlling sh at an unfair price, and material facts aren’tdisclosed to minority shs, a derivative action may lie if the nondisclosurecaused a loss to the minority shs. The plaintiffs must establish causation byshowing that an effective state remedy (e.g., injunction) was foregone becauseof nondisclosure.
14.BLUECHIP RULE--PRIVATE PLAINTIFF--a plaintiff can bring a private cause of actiononly if he actually purchased or sold the relevant securities. “Sale” includesan exchange of stock for assets, mergers and liquidations, contracts to sellstock, and pledges. The SEC can bring action under rule 10b-5 even though ithas neither purchased or sold securities.
a)DueDiligence--if a plaintiff’s reliance on a misrepresentation or omitted factcould have been prevented by his exercise of due diligence, recovery may bebarred. Mere negligence does NOT constitute a lack of due diligence, although aplaintiff’s intentional misconduct and his own recklessness (if D was merelyreckless) will bar recovery.
b)Inpari delicto--a private suit for damages under rule 10b-5 will be barred if:
1)Theplaintiff bears substantially equal responsibility for the violations, AND
2)Preclusionof the suit would not significantly interfere with the enforcement ofsecurities law.
a)Out-of-pocketDamages--this is the difference between the price paid for stock and its actualvalue.
1)Compare--benefit-of-the-bargaindamages--these are measured by the value of the stock as it really is and thevalue it would have had if a misrepresentation had been true.
2)Standardmeasure of conventional damages--out-of-pocket damages is the standard measurein private actions under rule 10b-5; benefit-of-the-bargain damages are usuallynot granted.
b)RestitutionaryRelief--this may be sought instead of conventional damages:
1)Rescission--returnsthe parties to their status quo before the transaction
2)Rescissionaryor Restitutionary damages--money equivalent of rescission
3)Differencebetween conventional damages and Restitutionary relief--out-of-pocket damagesare based on the P’s loss, while Restitutionary relief is based on the D’swrongful gain. Rescission or Rescissionary damages may be attractive remedieswhen the value of the stock changed radically after the transaction. However,Restitutionary relief is usually unavailable in cases involving publicly heldstock.
c)RemediesAvailable to the Government--although the SEC cannot sue for damages, it canpursue several remedies including special monetary remedies:
1)InjunctiveRelief--the SEC often seeks injunctive relief accompanied with a request fordisgorgement of profits or other payments that can be subject to criminalsanctions (fines and jail sentences) and civil penalties (up to three times theprofit gained or loss avoided).
17.JURISDICTION,VENUE, AND SERVICE OF PROCESS--suits under 10b-5 are based on the 1934 Act, andexclusive jurisdiction is in the federal district courts. State claims arisingout of the same transactions may be joined with the federal claim under thesupplemental jurisdiction doctrine. Venue can be wherever any act ortransaction constituting a violation occurred, or where the D is found ortransacts business. Process can be served where the D can be found or where helives.
18.STATUTEOF LIMITATIONS--the 1934 Act contains no SOL; however, the SCt has held thatprivate actions must be brought within one year after discovery of the relevantfacts and within three years following accrual of the cause of action. Thetolling doctrine is inapplicable.
a)Exceptions--thetime limitations don’t apply to all rule 10b-5 private actions, e.g., SEClimitations period of five years for private suits by contemporaneous tradersagainst purchasers or sellers who violate rules regarding trades while inpossession of material, nonpublic information. Further, the SEC is not subjectto any limitations period in civil enforcement actions.
D.SECTION16 OF THE 1934 ACT--Section 16 concerns purchases followed by sales, or salesfollowed by purchases, by certain insiders, within a six-month period.
1.FIRMSAND SECURITIES AFFECTED UNDER SECTION 16--Section 16 applies to those firms andsecurities that must be registered under section 12 of the 1934 act.
a)Reason--16(a)references registered securities under S12; S12(a) and 12(g) create theregistration requirement for securities; S12(g)creates an asset ($1 mln total)and distribution (500 to 700 depending on timing); 16(b) references “such”officers, etc., which refers to sub(a)
b)Note--tradingin all of a corp’s equity securities is subject to section 16 if any class ofits securities is registered under section 12.
2.DISCLOSUREREQUIREMENT--Section 16(a) requires every beneficial owner of more than 10% ofthe registered stock and directors and officers of the issuing corp to fileperiodic reports with the SEC showing their holdings and any changes in theirholdings.
a)Whois an Officer (16a-1f)--issuer’s president, principal financial director,principal accounting officer, any vice-president of the issuer in charge of aprincipal business unit, any other officer who performs similar policy-makingfunctions for the issuer.
3.LIABILITY--toprevent the unfair use of information, section 16(b) allows a corp to recoverprofits made by an officer, dir, or more-than-10% beneficial owner on thepurchase and sale or sale and purchase of its securities within a six-monthperiod.
a)Coverage--Section16(b) does NOT cover all insider trading and is NOT limited to trades based oninside info. The critical element is short-swing trading by officers, dirs, andmore-than-10% beneficial owners.
1)Note--beneficialowner must own 10% or more BOTH at he time of sale and purchase to be liableunder 16(b).
b)Calculationof short-swing profit--the profit recoverable is the difference between theprice of the stock sold and the price of the stock purchased within six monthbefore or after the sale.
1)Multipletransactions--if there is more than one purchase or sale transaction within thesix-month period, the transactions are paired by matching the highest saleprice with the lowest purchase price, the next highest price with the nextlowest price, etc. a court can look six month forward or backward from any saleto find a purchase, or from any purchase to find a sale
c)WhoMay Recover--the profit belongs to the corp alone. Although not a typicalderivative action, if the corp fails to sue after a demand by a sh, the sh maysue on the corp’s behalf. The cause of action is federal, so there is noposting of security requirement, and no contemporaneous sh requirement. Remedy:
1)Allsales and purchases within 6 months are included;
2)Damagescalculated as to maximize the gain to he company;
3)Matchhighest sale price against lowest purchase price within relevant period;continue until you can go no further.
d)Insiders--insidersare officers (named officers and those persons functioning as officers), dirs(actually serving or who authorized deputization of another), and beneficialowners of more than 10% of the shares. Insider status for officers and dirs isdetermined at the time they made a purchase or sale. Transactions made beforetaking office is NOT within section 16(b), but those made after leaving officeare subject to the statute if they can be matched with a transaction made whilein office. Liability is imposed on a beneficial owner only if he owned morethan 10% of the shares at the time of both the purchase and sale.
e)”Purchaseor Sale”--this includes any purchase of stock. Unorthodox transactions thatresult in the acquisition or deposition of stock (e.g., merger for stock,redemption of stock) are also purchases and sales.
E.SECTION16(B) COMPARED TO RULE 10B-5:
a)CoveredSecurities--Section 16(b) applies to securities registered under the 1934 act;rule 10b-5 applies to all securities.
b)InsideInformation--Section 16(b) allows recovery for short-swing profits regardlessof whether they are attributable to misrepresentations or inside info; rule10b-5 recovery is available only where there was a misrepresentation or a tradebased on inside info.
c)Plaintiff--recoveryunder section 16(b) belongs to the corp, while rule 10b-5 recovery belongs tothe injured purchaser or seller.
d)OverlappingLiability--it is possible that insiders who make short-swing profits by use ofinside info could be liable under both section 16(b) and rule 10b-5.
F.COMMONLAW LIABILITY FOR INSIDER TRADING--insider trading constitutes breach of fiduciaryduties owed to the corp, so the corp can recover profits made from insidertrading
a)CommonLaw Liability Compared To Section 16(b) Liability--both common law and section16(b) liability run against insiders and in favor of the corp. However, unlikesection 16(b), the common law theory applies to all corps (not just those withregistered securities), recovery can be had against any corporate insider, thepurchase and sale is NOT limited by a six-month period, and the transactionmust be based on the inside info.
b)CommonLaw Liability Compared to Rule 10b-5 Liability--the theories of recovery aresimilar except that under the common law recovery runs to the corp (not to theinjured purchaser or seller), there is no purchaser or seller requirement, andnoninsiders (tippees) have not yet been held liable.
1.RIGHTTO VOTE IN GENERAL--shs may generally vote for the election and removal ofdirs, to amend the articles or bylaws, and on major corporate action or fundamentalchanges.
a)WhoMay Vote--the right to vote is held by shs of record as of the record date;
b)Restrictionson Right--shares may be either voting or nonvoting, or have multiple votes pershare.
2.SHAREHOLDERMEETINGS--generally, shs can act only at meetings duly called and noticed atwhich a quorum is present.
a)Compare--informalaction--statutes permit sh action without a meeting if there is unanimouswritten consent of all shs entitled to vote.
a)StraightVoting--this system of voting allows one vote for each share held and appliesto all matters other than director elections, which may be subject tocumulative voting. Certain fundamental changes (e.g., merger) frequentlyrequire higher shareholder approval.
b)CumulativeVoting For Director--this system allows each share one vote for each directorto be elected, and the votes may be cast all for one candidate or divided amongcandidates as the sh chooses, thereby helping minority shs to elect a dir.Cumulative voting may be mandatory or permissive.
4.VOTINGBY PROXY--a proxy authorizes another person to vote a shareholder’s shares. Theproxy usually must be in writing, and its effective period is statutorilylimited unless it is validly irrevocable.
a)Revocability--aproxy is normally revocable by the sh at any time, although it may be madeirrevocable if expressly stated and coupled with an interest in the sharesthemselves. Absent written notice to the corp, the death or incapacity of a shdoes NOT revoke a proxy. a sh may revoke a proxy by notifying the proxy holder,giving a new proxy to someone else, or by personally attending the meeting andvoting.
b)ProxySolicitation--almost all shs of publicly held corps vote by proxy.Solicitations of proxies are regulated by the Securities Exchanges Act of 1934Section 14a, federal proxy rules and, in some cases, state law. Federal proxyrules apply to the solicitation of all proxies of registered securities, butNOT to nonmanagement solicitation of 10 or fewer shs. The term “solicitation” isbroadly interpreted by the SEC to include any part of a plan leading to aformal solicitation, e.g., inspection of shareholder list.
1)1992amendments--the SEC revised the proxy rules to make it easier for shs tocommunicate with each other. Significant changes include: a safe harbor forcommunications that don’t involve solicitation of voting authority, relaxationof requirements involving broadcast of published communications, relaxedpreliminary filing requirements for solicitations, and removing communicationsbetween shs concerning proxy voting from definition of “solicitation.”
2)Requirementof Full Disclosure--the proxy rules require full and accurate disclosure of allpertinent facts and the identities of all proxy participants, disclosure ofcompensation paid to certain officers and dirs, and disclosure ofconflict-of-interest transactions involving more than $60, 000.
3)Inclusionof Shareholder Proposal--shareholder proposals must be included in corporateproxy materials if the proponent is a record owner or beneficial owner of atleast 1% or $1000 worth of securities entitled to vote on the matter. Theproposal must not exceed 500 words.
I)Exceptions--aproposal need NOT be included if it: is not a proper subject for shareholderaction, would be illegal, is false or misleading, seeks redress of a personalclaim, relates to operations accounting to less than 5% of the corp’s totalassets and is not otherwise related to the corp’s business, concerns a matterbeyond the corp’s power to effectuate, relates to ordinary business operations,relates to an election to office, is counter to a proposal submitted by thecorp at the same meeting, is moot or duplicate, deals with the same subjectmatter as a very unsuccessful prior proposal, or relates to specific amounts ofcash or stock dividends.
ii)Privateright of action--a private right of action is available to a sh whose proposalwas rejected by the corp on the ground that it fails within one of theexceptions.
iii)Providingshareholder lists--a sh has a right to obtain a list of shs or to have hiscommunication included with the corporate proxy materials.
4)Remediesfor violation of proxy rules--these include suit by the SEC to enjoinviolations or to set aside an election and individual suits, class actions, orderivative suits by the shs (In a private suit, the P must show materiality andcausation, but causation is normally presumed from materiality. Fairness to thecorp is NOT a defense to a violation of proxy rules ). The court may rescindcorporate action resulting from a misleading proxy solicitation or awarddamages.
c)ExpensesIncurred In Proxy Contests--corporate funds may be used by management with respectto reasonable proxy solicitation expenses incurred in order to obtain a quorumfor the annual meeting or regarding controversy over corporate policy (asopposed to a personnel controversy). The corp may, with sh approval,voluntarily pay the reasonable expenses to insurgents who win a proxy contestinvolving policy.
5.OTHERMETHODS TO COMBINE VOTES FOR CONTROL (CLOSE CORPORATIONS)--other methodsinclude shareholder voting agreements which may be enforced by specificperformance, agreements regarding greater-than-majority approval, shareholderagreements binding the discretion of dirs, and voting trusts.
B.RESTRICTIONSON TRANSFER OF SHARES--although most frequently used in close corps, stocktransfer restrictions may also be imposed by larger corps (e.g., to restrictownership to employees). The two most common types of restriction are a rightof first refusal and a mandatory sell-buy provision. Restrictions must bereasonable and will be strictly construed.
a)NoticeRequirements--a lawful stock transfer restriction is of no effect unless notedconspicuously on the stock certificate. If there is no such notice, an innocenttransferee is entitled ti have the shares transferred to him.
1.TYPESOF BOOKS AND RECORDS--these include shareholder lists, minutes, financialrecords, and business documents.
2.COMMONLAW--at CL, a sh has a right to inspect records for proper purpose.
3.STATUTES--statutesgovern these rights in most states. Many statutes apply only to certain shs butare usually interpreted to supplement the common law. Most statutes preservethe proper purpose test, but place the burden on the corp to prove improperpurpose.
4.PROPERVERSUS IMPROPER PURPOSES--the test is whether the sh is seeking to protect thesh interest. Multiple purposes that include a proper one usually will notpreclude inspection. Generally, a sh can inspect the sh list because it isoften necessary to the exercise of other rights like proxy fights, shlitigation, etc. Inspection of a sh list for proxy contest is a proper purpose.However, it has been held that corporate records cannot be examined solely forthe purpose of advancing political and social views or to aid a sh as alitigant on a personal, non-shareholder claim.
5.COMPARE--MANDATORYDISCLOSURE OF INFORMATION--a sh’s inspection right is separate and distinctfrom the statutory requirements governing the affirmative disclosure of certaininformation by corps (e.g., Section 12 of Securities Exchange Act of 1934,proxy rules, state statutes).
D.FIDUCIARYOBLIGATIONS OF CONTROLLING SHAREHOLDERS--a controlling sh owes a fiduciary dutyin his business dealings with the corp, in taking advantage of corpopportunities (rules more lenient than those applied to dirs and officers), andin causing fundamental changes.
1.ACTIONSENTIRELY IN SHAREHOLDER CAPACITY--a controlling sh must NOT act to benefithimself at the expense of the minority shs; i.e., in a transaction wherecontrol of the corp is material, he must act with good faith and inherentfairness toward the minority.
2.OBLIGATIONSOF SHAREHOLDERS IN CLOSE CORPORATIONS--both majority and minority shs owe eachother an even stricter duty (utmost good faith and loyalty) than is owed bycontrolling shs in publicly held corps. This duty has been interpreted to meanthat there must be equal treatment of all shs, i.e., they must be affordedequal opportunities.
3.DISCLOSURE--acontrolling sh must make full disclosure when dealing with minority shs.
4.SALEOF CONTROL--in most jurisdictions, a controlling sh is permitted to sell hisstock at a premium, i.e, a price not available to other shs. Exceptions tothese rule include a bare sale of office (invalid), the corporate actiontheory, sales involving fraud or nondisclosure, and knowing sales to transfereeswho plan to loot or deal unfairly with the corp.
1.DIRECT(INDIVIDUAL) SUITS--a direct suit may be brought by a sh on his own behalf forinjuries to sh interests. If the injury affects a number of shs, the suit maybe brought as a class action.
2.DERIVATIVESUITS--if a duty owed to the corp has been abridged, suit may be brought by ash on behalf of the corp.
a)DistinguishDirect From Derivative Suits--the test is whether the injury was suffered bythe corp directly or by the sh, and to whom the D’s duty was owed
1)Closecorporations--in some cases, minority shs have been allowed to bring a directaction against controlling shs for breach of fiduciary duty
b)Prerequisiteto Suit--Exhaustion of Corporate Remedies--the P-sh must specifically plead andprove that he exhausted his remedies within the corporate structure
1)Demandon directors--the P-sh must make a demand on the dirs to remedy the wrong,unless such demand would have been futile. Note that in the absence ofnegligence, self-interest, or bias, the fact that a majority of dirs approvedthe transaction does NOT itself excuse the demand.
I)Modelstatutes--under both model statutes, demand should be excused only if it isshown that irreparable injury to the corp would result;
ii)Effectof rejection of demand--if the matter complained of does not involve wrongdoingby the dirs, the board’s good faith refusal to sue bars the action, unless theP-sh can raise a reasonable doubt that the board exercised reasonable businessjudgment in declining to sue. If the suit alleges wrongdoing by a majority ofdirs, the board’s decision not to sue will NOT prevent the derivative suit.
2)Demandon shareholders--in most states, the p-sh must also make a demand on shs unlessexcused (e.g., the alleged wrongdoing is beyond the power of the shs toratify). Where demand on shs is required, a good faith refusal to sue by themajority of disinterested shs will preclude the suit.
c)Qualificationsof Plaintiff--a few states require the P to be a registered sh; most statesalso allow a beneficial owner of shares to bring suit. Also, a sh of a parentcorp can bring a derivative suit on a subsidiary’s cause of action. Shs cannotcomplain of wrongs committed before they purchased their shares except:
1)wherethe P acquires shares by operation of law;
2)insection 16(b) violations;
3)whereserious injustice will result;
4)wherethe wrong is continuing in nature.
The Pmust fairly and adequately represent the interests of all shs
d)SecuritiesFor Expenses--in a number of states, the P, under certain circumstances, mustpost a bond to indemnify the corp against certain of its litigation expenses,including attorney’s fees, in the event the P loses the suit. a p-sh who losesmay also be liable for the court costs incurred by the parties.
e)Defenses--defensesto derivative suit include the SOL and equitable defenses (laches, uncleanhands, etc);
f)SettlementAnd Recovery--any settlement or judgment belongs to the corp, absent special circumstances.Settlement or dismissal of the suit is generally subject to court approvalafter notice to all shs.
g)Reimbursementto Plaintiff--a victorious plaintiff may be entitled to reimbursement from thecorp for litigation expenses;
h)Indemnificationof Officers And Directors--indemnification issues arise when officers and dirsare sued for conduct undertaken in their official capacity. If the officer ordir wins on the merits, he may be indemnified. Most statutes also authorize thecorp to advance (not pay) expenses in defending against the claim. Statutesvary where the officer or dir settles or loses; they are most liberalconcerning indemnification in a third-party suit as opposed to a derivativesuit.
I)LiabilityInsurance--in most states, a corp can obtain liability insurance for itsindemnification costs and for any liability incurred by its officers in servingthe corporation.
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